Traceys Home Center, a retailing company, has two departments, Bath and Kitchen. A recent monthly contribution format income statement for the company follows:

			Department
	Total		Bath		Kitchen
Sales	$5,000,000		$1,000,000		$4,000,000
Less variable expenses	1,900,000		300,000		1,600,000
Contribution margin	3,100,000		700,000		2,400,000
Less fixed expenses	2,700,000		900,000		1,800,000
Net operating income (loss)	$400,000		($200,000)		$600,000

A study indicates that $370,000 of the fixed expenses being charged to the Bath Department are sunk costs or allocated costs that will continue even if the Bath Department is dropped. In addition, the elimination of the Bath Department will result in a 10% decrease in the sales of the Kitchen Department.

Required

If the Bath Department is dropped, what will be the effect on the net operating income of the company as a whole?

Problem 2--Make or Buy (6 points)

The Tracey Company produces wheels which are used in the production of bicycles. Traceys costs to produce 100,000 wheels annually are:

Direct materials $ 30,000

Direct labor 50,000

Variable overhead 20,000

Fixed overhead 70,000

Total $170,000

An outside supplier has offered to sell Tracey similar wheels for $1.25 per wheel. If the wheels were purchased from the outside supplier, $15,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $45,000 per year.

Required

1. If Tracey chooses to buy the wheel from the outside supplier, then the change in annual net income due to accepting the offer would be: (be sure and tell me if it is an increase or decrease and only use the relevant costs)

2. What is the highest price that Tracey could pay the outside supplier for the wheel and still be economically indifferent between making or buying the wheels?

3. If Tracey continues to make the product, what is the accounting word that is used to describe the $45,000 rent that they are giving up?

Problem 3--Special Order (6 points)

Hawkins Company produces a single product. The cost of producing and selling a single unit of this product at the companys current activity level of 60,000 units per year is as follows:

Direct materials $5.10

Direct labor 3.80

Variable manufacturing overhead 1.00

Fixed manufacturing overhead 4.20

Variable selling and administrative expenses 1.50

Fixed selling and administrative expenses 2.40

The normal selling price is $21 per unit. The companys capacity is 75,000 units per year. An order has been received from a mail-order house for 15,000 units at a price of $14 per unit. This order would not affect regular sales.

Required

1. If the order is accepted, by how much will annual profits be increased or decreased? The order would not change the companys total fixed costs. Show computations to support your answer and be sure to identify the dollar amount as either an increase or decrease.

2. Suppose the company does not have enough idle capacity to produce all of the units for the overseas customer and accepting the special order would require cutting back on production of 5,000 units for regular customers. What would be the minimum acceptable price per unit for the special order?

3. Assume the company has 1,000 units of this product left over from last year that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units? Explain (briefly). (I am looking for a dollar amount and for one particular word that describes the costs you did not consider relevant.)